This is a brutal assesment from Bonitas Research.

I havent dug into it yet, but wanted to give investors a heads up.

Opening paragraphs:

Listed in 2014, Rural Funds Group (ASX: RFF) (“RFF”, the “Company”) presents itself as a successful real estate investment trust (“REIT”) with an enviable portfolio of Australian agricultural assets that offers investors an attractive dividend yield without exposure to traditional farming business risks. Not all is what it seems.

Evidence suggests that RFF’s reported profitability had included A$ 28+ million of fabricated rental income paid to RFF by its two largest third-party lessees. We believe that RFF had artificially inflated its reported financial performance to raise cash from the capital markets for two reasons: (1) to finance its attractive ~76% payout ratio to shareholders; and (2) to conduct multiple nefarious transactions between RFF and RFF Management’s privately-held business, Rural Funds Management (“RFM”) in order to siphon assets into RFM for RFF Management’s own personal gains.

Read the rest here

Drought and other factors that affect farm productivity will certainly impact the profitability of RFF's tennants. But as landlord, the only thing that matters is that the rent continues to be paid. That's very much a non-discretionary spend for tennants, so only becomes a problem if things get really dire.

Prolonged drought, or other adverse environmental changes, could of course impact land values, and that would certainly have an impact on the balance sheet and rental pricing power.

There's some safety in the geographic diversity of assets, as well as diversity across different commodity types.

Rural Funds Group (ASX:RFF) is a Real Estate Investment Trust (REIT) that owns a diversified portfolio of 35 properties, farming equipment and water rights spread across a variety of geographies and agricultural sectors.

It is not directly exposed to the operational risks of the underlying farming operations -- these risks are borne by the leasees — including corporate operators such as Treasury Wine Estates (ASX:TWE) andSelect Harvests (ASX:SHV) — who are under long term lease agreements.

These leases can last for many years, have indexed rents (either fixed or CPI based) and include periodic rent reviews. They are typically ‘triple net’ which effectively means the tenants pay for the rates, insurance and upkeep. At present, the weighted average lease length to expiry is around 13 years.

The industry is extremely fragmented and there are ample opportunities for expansion.

This slide from UBS investor presentation, Nov 2017

AFFO

Accounting adjustments to the carrying value of assets — such as vines and orchard trees, as well as investment properties — can mask the cash generative capacity of the business. As such, Rural Funds Group’s preferred measure of earnings is the Adjusted Funds From Operations (AFFO). Basically, it strips out non-cash charges like depreciation but adds back recurring capital expenditures.

It should be noted that the ongoing prosecution of Rural Fund Group’s expansion strategy will almost certainly entail future capital raisings — so potential investors should bear that in mind. Equity finance is often an attractive and low cost source of funds, and so long as that’s put to good use, per share performance should improve over time. That’s certainly been the case so far.

Rural Funds Group’s strategy is both straightforward and well-practiced: Acquire land, sign long-term leases with high-quality operators and improve properties. Earnings rise as rents and land values increase, and as the portfolio improves and expands.

To date, Rural Funds Group has great form here, and the opportunity has a long way to run.

The low level of institutional ownership in agricultural land in Australia suggests significant expansion potential. Rural Funds Group estimates that there is $150 billion worth of investment grade agricultural properties in Australia, of which only around 15% is institutionally owned. That compares with 40% in the US and parts of Europe. With the increasing competitiveness of corporate farming and challenges for farming families with intergenerational wealth transfer (that is, fewer kids are choosing to work on the family farm as a career), we think there’s significant potential here.

Importantly, a lot of farming land is believed to be operating sub-optimally due to the capital constraints of existing owners and a resulting lack of investment. This gives Rural Funds Group plenty of development opportunities, which will act to improve the productivity and, ultimately, rents and land values.

For example, the construction of new dams, irrigation, fencing and storage facilities can greatly increase the productive capacity of properties. Additionally, acquired property can be repurposed to serve more productive uses, such as converting to higher value crops. There are some great examples in the group‘s latest investor newsletter.

Property enhancements, combined with a limited supply of quality land, have helped agricultural land values rise at an attractive clip, historically — 4.8% per annum on average over the last four decades or so. General population growth coupled with the rise of the Asian middle class (and the resultant growth in demand for Australian agricultural products) should also go a long way in supporting land values over time.